Please see addendum of this report for important disclosures. www.cowen.com

Conclusion: The Cowen Biotech Team has been writing about potential surprises that could impact the biotech industry in the coming year each year since 2007. (See today's report under a separate cover: "Top 10 Potential Surprises for 2013.") With five years of history under our belt, we've taken a look back to see how some of our predictions have played out. As is to be expected, many were off base, a few were spot on, and others are just plain dated. Because one can always gain something from reviewing the past (even if
just a laugh), we've compiled some of our best and worst predictions into this report.

Most CorrectEditor's note: Not only did Nadeau's prediction prove right for 2010, it proved correct through 2011 and into 2012. By the time Vancocin generics were finally launched, ViroPharma's share price had moved from $7.57 on December 9, 2009 to $22.44 on April 10, 2012.

Vancocin Generics Still Don't Come To Market
Probability: 15%

Consensus view: On August 4 the Pharmaceutical Science and Clinical Pharmacology Advisory Committee voted unanimously in support of the FDA's Office of Generic Drugs (OGD) draft guidance on bioequivalence for Vancocin capsules. The draft guidance allows the use of in vitro bioequivalence testing to characterize the generic versions of Vancocin, and does not require clinical trials. As in vitro bioequivalence testing is easy to perform, this should allow the quick introduction of generic Vancocin into the U.S. market. Following the Advisory
Committee's vote, biotech publications reported that there could be as many as five generic Vancocins waiting for approval. Therefore, with generics likely to flood the market early in 2010, ViroPharma should be afforded little value for Vancocin.

Why a surprise is possible: It has been over 4 months since the Advisory Committee, and generics have yet to be launched. This suggests the process may not be as easy as assumed. In fact, the OGD's draft guidance does not allow all generic formulation of oral vancomycin to be approved based on in vitro bioequivalence testing, but rather requires that the formulation contain the same active and inactive ingredients in the same amounts as Vancocin HCl capsules. Moreover, the guidance specifically states that, in reference to the inactive ingredients, "Thus, to obtain approval of an ANDA using the in vitro approach, the applicant must show that its product contains the same inactive ingredients in the same amount as the RLD product, and that these inactive ingredients meet equivalent standards to those used in the RLD product."

Therefore, the guidance could actually pose two challenges to the generic companies. First, the companies must have formulated their generic Vancocins exactly the same as ViroPharma. Little is known about the formulations developed by the generics, and therefore it is unclear if any (or all) have the same concentrations of inactive ingredients as Vancocin. It is possible that some (or all) of the generic Vancocins may need to be reformulated before they can submit for approval using the in vitro method, which could push out their approval by several quarters. Second, the generic companies must show that their inactive ingredients meet standards equivalent to the ingredients used in Vancocin. However, how will the generic companies know the exact standards of the inactive ingredients used in Vancocin? Certainly ViroPharma won't disclose them, and to the extent they are proprietary and/or trade secrets, the FDA cannot divulge them to the generic companies. If the companies must determine them empirically, this could require some time, and push out the approvals.

Expectation on timing of event: Our model assumes Vancocin generics enter on January 1, 2010. Therefore, every day without them is a minor victory for VPHM.

Stock impact if surprise comes true: Our model estimates that Vacocin will exit 2009 at a $200MM/year run rate, but that generic competition will reduce sales to $60MM for 2010. Therefore, should generics not come at all, our Vancocin estimate would be low by about $140MM. With 96% gross margins on Vancocin, and ViroPharma maintaining little Vancocin infrastructure, that revenue would result in about $134MM in pre-tax margin, or about $94MM in net income (assuming a 30% tax rate). We expect investors will give ViroPharma credit only for the increase in its cash balance that this income brings, and would be hesitant to attach an earnings multiple to it. Nonetheless, $94MM would add about $1.22/share in cash. At VPHM's current $7.57 stock price, that would move the stock 16% higher.

Most WrongEditor's note: Soliris's safety profile has been essentially spotless since this piece was written in December 2008, allowing the drug's sales to grow from $259MM in 2008 when this was published to over $1B. The analyst who authored this piece shall remain nameless, although we sorely miss her contributions from our San Francisco office.

ALXN's Soliris Suffers From Safety ConcernsProbability: 8%

Consensus view: The consensus view is that ALXN's Soliris is a very safe drug with few side effects that can be dosed every other week chronically for a lifetime. There are a handful of patients that have been taking Soliris for 6+ years, with no untoward effects. Soliris brings with it substantial clinical benefit to patients in its labeled indication PNH, a rare blood disorder associated with hemolysis, anemia, thrombosis, and kidney disease. All patients are vaccinated prophylactically against meningococcal infection prior to receiving Soliris, which eliminates any infection risk.

Why a surprise is possible: Soliris is a monoclonal antibody that functions by inhibiting the C5 component of the complement cascade in the body's immune system. This mechanism of action prevents destruction of the PNH clone, which is missing receptors on the cell surface that protect it from complement surveillance, ultimately leading to a significant reduction in red blood cell destruction, as well as the downstream clinical consequences noted above. However, blockade of C5 poses an infection risk to patients, as C5 is responsible for the assembly of an "attack membrane complex," which is critical for complement dependent bactericidal activity. According to the FDA published review of Soliris, inhibition of complement may impair a patient's ability to clear infections with encapsulated organisms. Examples of encapsulated organisms include haemophilus influenzae B (Hib), streptococcus pneumoniae, meningococcus, group B streptococcus, and salmonella typhi. Indeed, in patients with a natural "late" complement deficiency, the key infection risk is meningococcal disease. In Japanese patients with a C9 deficiency, which is one of two byproducts of C5, patients are at a 1,400-fold risk of developing meningitis relative to complement sufficient individuals. Additionally, according to the medical literature, 60% of patients with C9 deficiency develop meningococcal disease, and about half experience recurrent disease. The relapse rate defined at <1 month from prior infection in these individuals is 10x greater than in normal individuals. That said, interestingly these patients experience a lower fatality rate that in complement sufficient individuals. Despite vaccination against meningitis, 2/236 (0.8%) patients in the Soliris PNH clinical trials developed meningitis (1 unvaccinated patient with a different condition developed meningitis as well and had a complicated course). Both patients had been on drug for about one year, and neither died. This rate of infection may grow, as (1) more patients get onto drug (2) in a less controlled setting than clinical trials (3) increased duration of drug therapy may not eliminate the risk. We estimate there were roughly 550 PNH patients receiving Soliris by the end of 2007, approximately 1,000 by the end of 2008, and there will be >1,300 by the end of 2009.

Expected timing of event: Any time in 2009, or later

Stock impact if surprise comes true: ALXN stock could be significantly negatively impacted if the infection rate led to lighter than expected new patient starts or
discontinuation of existing patients.

FunniestEditor's note: Nadeau struck a great chord with this piece from December 2009, but he is still trailing Schmidt in the luck department.

The Vesivirus Infects… One Of Schmidt's CompaniesProbability: 2%

Consensus view: Genzyme is either (1) Incompetent, (2) Cursed, (3) Unlucky, or (4) some combination of #'s 1 – 3. In any case, Genzyme is the only company flawed enough to be brought to its knees by a puny virus. The vesivirus is unlikely to infect the reactors of any other biotech company, and on the off chance that it does, all other biotechs have sufficient redundancy in manufacturing, or enough inventory on hand, so that a manufacturing disruption will not decrease sales meaningfully.

Why a surprise is possible: According to Genzyme, the vesivirus entered its Allston, MA and Geel, Belgium facilities through shipments of raw materials purchased from external vendors. This happened once in the Fall of 2008 (both Allston and Geel were affected, although supply was not disrupted) and then again in the Spring of 2009 (just Allston, with major disruptions to the supplies of Fabrazyme and Cerezyme). However, Genzyme has not been able to identify exactly which raw material, or which vendor, as there are no discernible similarities shared between the separate events. As Genzyme's CHO-cell manufacturing technology uses many of the same raw materials as most other biologic manufacturing facilities, it would seem unlikely that the raw material(s) that brought the virus to the Genzyme facilities would be purchased only by Genzyme. Therefore it is quite possible that some other biologic manufacturer could (or did) receive a contaminated shipment. Once introduced into a bioreactor, the vesivirus would cause any mammalian cell reactor to fail, just as it did in Allston and Geel, and the only way to remove it from the reactor subsequently would be to partially or completely shut down the plant in order to sterilize it. So if the vesivirus could infect nearly any biologic manufacturing facility, which companies would be most sensitive to a halt in manufacturing at one of their plants? These companies would, like Genzyme, have little redundancy in their manufacturing, and less than a few of quarters of inventory on hand. The prolonged stoppage of the production at a single facility would lead to a significant disruption in supply. Quantifying inventory levels for specific products is quite difficult based on publicly-available information. Nonetheless, the SEC filings for several companies suggest sole-source manufacturing, and/or potentially limited inventory.

• Until its new Rhode Island facility receives FDA and EMEA approvals next year Alexion relies on a single source for Soliris. According to its recent 10Q, Alexion has about $33MM of Soliris finished goods on hand. Assuming those were expensed at cost, and that Soliris has COGS of 12%, that translates into $276MM in end-user sales, just over 2 quarters according to our projections.
• In its 10K, Amgen notes that all of its bulk manufacturing for Aranesp, Neulasta, and Neupogen occurs at its Puerto Rico facility, and all of the formulation, fill, and finish for Epogen, Aranesp, Neulasta, and Neupogen also take place there. A significant, prolonged issue at the Puerto Rico facility has the potential to impact a number of major products.
• Tysabri is produced solely at Biogen Idec's North Carolina facility. This will continue to be Tysabri's sole manufacturing site until Biogen's Danish facility is licensed in 2011 or 2012.

Expected timing of event: Thursday, April 1, 2010 or Friday, August 13, 2010.

SaddestEditor's note: Who knew that when this piece was written (December 2009) the Chip Skowron and Matthew Martoma scandals were already well underway? Well, at least that is Schmidt's story and he is sticking to it.

Hedge Fund Scandal Hits BiotechProbability: 10%

Consensus view: Hedge funds can be aggressive traders of securities, and can go to great lengths to gather information. Nonetheless, the alleged improprieties at Galleon and other firms likely represent an isolated case that is limited to a few investors who cover the technology industry. Most hedge funds employ large legal and compliance teams to help ensure ethical standards of the highest quality.

Why a surprise is possible: We have no reason to think that any hedge fund or other investor has done anything illegal, especially as it pertains to biotech investing. However, in today's world that may be of little consolation as those accused of financial wrong doing are often convicted in the court of public opinion before being given the opportunity to defend themselves in the court of law. As evidenced by Galleon's quick demise, an SEC indictment that receives substantial media attention can make it untenable for a fund to continue to operate. Should the SEC follow through on rumors that it plans to indict multiple additional funds, the fallout could be rapid regardless of the strength of any case. Moreover, investing in biotechnology stocks is differentiated from all other sectors by a surplus of binary events, information, and jargon. A governmental enforcement agency staffed by lawyers who have little knowledge of the sector might easily jump to the conclusion (rightly or wrongly) that material, non-public information has changed hands.

Expected timing of event: Any point in 2010.

Stock impact if surprise comes true: Any impact clearly would depend on the number and type of funds indicted and whether or not those funds could survive public scrutiny. Small and mid cap biotechnology companies are particularly dependent on the support of hedge fund investors. It is estimated that hedge funds account for up to 60% of the trading volumes in many small and mid cap biotechnology stocks, and that a scandal to create major liquidity issues for the sector. A scandal could also pressure individual stocks with a high hedge fund ownership concentration. For illustrative purposes only, companies in our coverage universe with the highest percentage of hedge fund ownership are:

Most PrescientEditor's note: It is hard to believe that internal R&D spending was so out of favor with investors just two years ago. While Schmidt scores points for calling the resurgence and identifying BG-12, Eylea, Zaltrap, and Kalydeco as interesting, his EXEL pick is still underwater.

Biotech Stops "Wasting" Money On R&DProbability: 12%

Consensus view: Investor sentiment toward investment in R&D has grown very negative. Many believe that internal R&D spending is wasteful, and ascribe little value to such investment when applying a DCF-based approach to valuing stocks. Activist investors are increasingly calling for companies to cut back on reinvestment and return cash to shareholders.

Why a surprise is possible: Any list of biotech's most notable 'big spenders' is likely to include Amgen, Biogen Idec, Vertex, Regeneron, and Exelixis. Historically each of these companies has been criticized for "black hole"-type spending on earlystage research programs with limited visibility. However, the next 12 months will feature data from a variety of clinical trials that could serve reverse this sentiment. Already Exelixis appears to have struck gold with XL184 for treating bone metastases. EXEL shares are up 71% following positive Phase II data presented at EORTC in November. Success from one or two additional home-grown biotech projects could serve to remind investors that (1) innovation is not dead, (2) blockbuster drugs do not materialize out of thin air, and (3) disciplined approach to internal R&D spending may be more optimal than growth via increasingly competitive in-licensing/M&A auctions.

Most EmbarrassingEditor's note: We don't know which is worse, this piece from December 2008, or the fact that Nadeau is still chirping about how UTHR is recommended in today's "Top 10 Potential Surprises Of 2013" report.Other Editor's note: While Schmidt is not one to let the truth get in the way of a good story, we would like to point out (1) The FREEDOM-M trial did succeed (admittedly in 2011), and (2) UTHR's stock was up 64% in 2009. Who is embarrassed now?

Consensus view: Oral remodulin's development program was poorly designed and executed. The FREEDOM-C trial used the wrong dose for much of the trial. Because the dose was too high, there was a high drop out rate, fatally dooming the study. FREEDOM-C's failure took UTHR down 35% in a year when we could have used all the performance we could have found. Worse, oral remodulin's next Phase III, the FREEDOM-M trial, suffers from the same dosing issues as FREEDOM-C, and is therefore unlikely to succeed when data are released in March. We won't step on that same landmine twice. We hate oral remodulin.

Why a surprise is possible: Succinctly, United Therapeutics has realized its mistake, and is working to improve the chances that FREEDOM-M will succeed. The FREEDOM-M trial is a Phase III trial of oral remodulin in patients who are not receiving any other therapy for their pulmonary hypertension. As originally designed, the trial was to be a 150-patient study, giving it 90% powered at p=0.05 assuming a 50m improvement in six minute walk distance and a 75m standarddeviation. The issue with FREEDOM-C was that 30% of patients had access only to the 1mg size oral remodulin pill, and they had many side effects, a high drop out rate, and therefore the drug produced poor efficacy in this population. In November,
United Therapeutics disclosed that about one-third of patients in FREEDOM –M also had access to only the 1mg dose during the study. As FREEDOM-C was much more
highly powered than FREEDOM-M, it is hard to see how FREEDOM-M could succeed. To rectify the problem, United Therapeutics is likely to increase enrollment in FREEDOM-M by 75 patients. All of these patients will have access to the 0.25mg oral remodulin pill. In FREEDOM-C, no patients with access to the 0.25mg pill dropped out, and those patients had a mean change in six minute walk distance of 28m. Unfortunately, in FREEDOM-C such patients made up only 15% of the trial, and therefore could not carry it. As redesigned, about 55% of patients in FREEDOM-M will have access to the 0.25mg pill, which makes success plausible. Moreover, United Therapeutics may change the endpoints of FREEDOM-M, so that there are two coprimary. One would be six minute walk distance in all-comers, which would need to be achieved with p=0.04. With a majority of patients in the study on the 0.25mg pill, success is possible. The second would be six minute walk distance in those patients who had access to the 0.25mg dose. United Therapeutics expects this would need to be hit with a p-value of 0.01. We expect that there will be about 125 patients in the study with access to the 0.25mg pill, suggesting a p-value of 0.01 in this population may be aggressive, but certainly achievable. The increase in enrollment will likely delay data from FREEDOM-M from March 2009 to the end of the year. If successful, it would be just in time to make some investors' years, and cause them to proclaim their love for oral remodulin forevermore.

Stock impact if surprise comes true: We have built a preliminary model that includes oral remodulin. We assume that it becomes a $500MM drug by 2014, which would add about $300MM to our prior remodulin franchise estimates (we assume that some of oral remodulin's sales come at the expense of other members of the franchise). Under this scenario, United Therpeutics would have just over $900MM in revenue by 2014, and just over $14 in pro forma EPS, with a 2009 – 2014 EPS CAGR of 27%. Should investors gain confidence in this scenario, we think UTHR would trade at 25x 2009, suggesting a stock price of about $125.

Most SarcasticEditor's note: We were right in thinking launch stocks might underperform during 2011, but that is of little consolation after a year in which we missed two of the biggest launch stories (REGN and MDVN).

A Drug Launches And The Stock OutperformsProbability: 20%

Consensus view: Unless you run a hedge fund, biotech launches are to be feared like the plague. During 2010, investors received another schooling in this lesson. Measuring stock performance from the day following FDA approval, shares of each of the four companies that launched its first major drug have underperformed: ACOR (-6%), AUXL (-35%), DNDN (-27%), and MNTA (-30%).

Why a surprise is possible: 2011 looks to be a solid year for launches with at least six biotechnology companies expected to introduce their first major product. These include Avanir (Neudexta), Cadence (Ofirmev), Human Genome Sciences (Benlysta), Orexigen (Contrave), Savient (Krystexxa), and Vertex (telapravir). The last company to execute on an initial product launch was Alexion (Soliris for PNH) in April 2007. Since that time, judging by stock price performance, there have been 13 consecutive launch disappointments: Omrix's Evithrom, Zymogenetics's Recothrom, Progenics's Relistor, Adolor's Entereg, GTC Biotherapeutics's Atryn, AMAG's Feraheme, Allos's Folotyn, Genmab's Arzerra, Dyax's Kalbitor, Acorda's Ampyra, Auxilium's Xiaflex, Dendreon's Provenge, and Momenta's M-Enoxaprin. Hence 1 in 14 historical launches have been successful from an investment viewpoint.

Assuming each of the six product launches of 2011 has a 1 in 14 chance of "success", there might be a 43% chance (6/14) of 2011 featuring a winning product launch. However, when factoring in (1) today's more restrictive reimbursement environment; (2) novel marketing impediments such as REMS programs, limits on DTC campaigns, restrictions on off-label promotion; (3) a more conservative and safety conscious physician base; and (4) that at least two of the six stocks on the 2011 list (VRTX and HGSI) sport near record valuations as pre-commercial companies; the odds of a launch translating into favorable stock performance in 2011 may be more like 20%.

Expected timing of event: 2011

Stock impact if surprise comes true: Upside in the stock with the successful product rollout will be dwarfed by the downside in the other five launch stocks of 2011.

Biggest KilljoyEditor's note: By writing about corporate bankruptcies during the 2011 holiday season, Schmidt would have you believe there may be more than one curmudgeon on the Cowen biotech team.

A Commercial-Stage Biotech Goes BustProbability: 5%

Consensus view: Biotech companies are like zombies in that they are incredibly difficult to kill off (and are always looking for brains). It is almost always possible to find a buyer of dilutive equity. Companies with marketed products have hard asset value, and may be acquired, but never go out of business.

Why a surprise is possible: The world of pre-commercial biotech financing has changed. It used to be thought (rightly, in our view) that companies without revenue had no business in the debt markets. Today we routinely see examples of precommercial biotechs with unprecedented multi-billion dollar equity valuations seeking to reduce dilution by raising capital through convert issuance, rather than a traditional equity financing. What is often underappreciated is the degree to which such financing strategies increase risk. As many of these biotech launches have failed to live up to lofty expectations, share prices have often fallen precipitously (perhaps accelerated by short interest from alarmed convert holders), and the
biotechs have found themselves the owners of ugly balance sheets with melting cash and, essentially, large lumps of straight debt. The debt increases the hurdle to achieving profitability (interest expense), tends to ward off potential new equity buyers, and can pose significant solvency issues as it nears maturation. While thus far, such companies have found ways to manage maturing debt (HGSI, AMLN), it is unclear how long this may continue. High short interest in some of these names may render convert refinancing impossible, and equity investors may finally lose appetite for money-losing businesses whose heavy debt burdens leave no path to profitability.
Some of the pre-launch or early commercial biotech companies with strikingly bloated debt balances include:

Stock impact if surprise comes true: While cash runways and the timing of debt obligations make it improbable that an actual bankruptcy will occur in any of these names during 2012, it is possible that investors essentially give up on one or more drug launches next year, and that debt obligations create a de facto bankruptcy in which equity values are driven toward zero.